Why Can’t We Just Build More Affordable Apartments?

December 15, 2014

In my last post, I talked about the need for a comprehensive approach to addressing the nation’s affordable housing supply deficit. This means focusing as much on preservation and rehabilitation programs and policies as on new affordable construction. Preservation and rehabilitation efficiently and relatively cost effectively transition existing stock into affordable stock while keeping aging and obsolete stock from disappearing from the pool altogether. But I still get asked the question: Why can’t our industry just build more affordable units?

To many outside observers, the biggest impediment to producing more new affordable units appears to be the industry’s appetite for profit. Unfortunately that is a far too simplistic and, frankly, uninformed diagnosis.

There are numerous apartment developers interested in doing more in the affordable housing space. However, to be sustainable over the long haul, new affordable housing properties need to be fiscally sound. That begins with a development pro forma that actually pencils. And more often than not, that’s not the case.

When I talk to developers who try to build more affordable product, particularly in expensive, high-barrier urban markets where the need for affordable housing is arguably the greatest, the refrain is typically that two factors, above and beyond anything else, make this kind of development virtually impossible for them to produce these much sought-after units:

Land. In an attractive market-take any major metropolitan area as an example-land can account for a significant portion of total development costs. Land in those markets is not only fundamentally more expensive to purchase than land in secondary or tertiary markets, but it also typically attracts multiple bidders, each seeking to deploy the land for diverse purposes, which further drives up costs. This cost increase can stretch or stress other financial assumptions and, in some extreme cases, even make the property impossible right out of the gate.

Entitlements. The entitlement process, which covers approvals, zoning and nearly everything in between, is an amalgam of outright costs, additional fees, land-use regulation (some of which can date back to the first half of last century) and code compliance. During the navigation of this often lengthy process, an apartment developer bears both direct and indirect costs with no assurance of a successful outcome. In some high-barrier-to-entry markets, entitlements can take four, five, six years or more before dirt actually moves. Some municipalities have tried to fast track this process, but they have met with varying degrees of success.

Many critics also advocate mandating the construction of more affordable through inclusionary zoning policies. However, such strategies again largely ignore the basic development economics that underpin any new multifamily housing property, as well as the realities of taking a project from concept to completion.

Earlier this fall, during NMHC’s annual Fall Board of Directors and Advisory Committee Meeting, I asked a developer member to walk attendees through the challenges of inclusionary zoning by illustrating the financial repercussions of building a new 250-unit apartment community in which 10 percent of the units were deemed affordable as a percentage of area median income (AMI).

It penciled out that the 10 percent mandate would reduce the project's return on cost by 51 basis points. To offset that return erosion, the land value would have to drop 36 percent.

While it was a theoretical exercise, it illustrated the point that there is a real per-unit cost to producing an affordable housing unit that affects various aspects of a development project, from financing to land acquisition to construction. In many cases, affordable unit set asides require developers to raise the rent on the market-rate units to offset those costs, affecting properties’ ability to compete in the marketplace.

So what is the solution? For starters, we need to recognize that addressing affordable housing needs of this magnitude requires a partnership at the local level between government and the private sector. Municipalities have the difficult task of trying to most efficiently manage their resources to the greatest benefit of their constituents, often challenged with balancing shrinking budgets and growing needs. However, local governments also have a tool box of things they can do to accelerate affordable housing production, helping developers and builders produce the units that are sought after, at a price point that households can afford and at a profit that encourages them to do so.

For example, municipalities can defer taxes and other fees for a set period of time to help the developer get the price points down. They also own tangible assets-buildings, raw land, entitled parcels-some of which can be leveraged to bring down the cost of construction or redevelopment. And they can help streamline the development and approval processes with fast tracking programs.

If local governments truly want more units affordable to more of its citizens, then they also need to get in the game and find ways to help the private multifamily sector bring down costs so they can parlay those savings directly into lower asking rents. When both the public and private sides bring all their tools and assets into play, the greater the likelihood of finding viable solutions to meet our affordable rental housing challenges.